Question 1

You own a portfolio which is invested equally in two stocks and a risk-free security. Beta is .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else being constant?
A)increasing the amount invested in the risk-free security
B)decreasing the weight of Stock B and increasing the weight of Stock A
C)replacing Stock A with a security that has a beta of .77
D)increasing the weight of Stock A and decreasing the weight of the risk-free security
E)replacing Stock B with Stock C, which has a beta equal to that of the market

Accepted Answer

The portfolio beta will increase if the weight of the higher beta stock (Stock B) and/or the weight of the risky assets in the portfolio is increased. Therefore, increasing the weight of Stock A and decreasing the weight of the risk-free security (choice D) will increase the portfolio beta. Choice A will decrease the portfolio beta as the risk-free security has a beta of zero. Choice C will decrease the portfolio beta as the replacement security has a lower beta than Stock A. Choice B may or may not increase the portfolio beta depending on the specific weights assigned to each stock. Choice E will have no effect on the portfolio beta as the beta of Stock C is equal to the market beta, which is the same as the current portfolio beta.

Question 2

Which one of the following is most commonly used as the measure of the overall market rate of return?
A)DJIA
B)S&P 500
C)NASDAQ 100
D)Wilshire 5000
E)Wilshire 3000

Accepted Answer

The S&P 500 is a broad-based index that tracks the performance of 500 large-cap companies listed on US stock exchanges. It is widely regarded as a good proxy for the overall market and is commonly used as a benchmark for measuring the overall market rate of return. The other options listed are also market indices, but they track different types of companies or have different selection criteria, making them less representative of the overall market.

Question 3

According to the capital asset pricing model, which of the following will increase the expected rate of return on a security that has a beta that is less than that of the market? Assume the market rate of return is greater than the risk-free rate and both rates are positive.
I. increase in the risk-free rate
II. decrease in the risk-free rate
III. increase in the market risk premium
IV. decrease in the market rate of return
A)I and III only
B)II and III only
C)I and IV only
D)II and IV only
E)II, III, and IV only

Accepted Answer

The expected rate of return on a security according to the Capital Asset Pricing Model (CAPM) is given by the formula: $E(R_i) = R_f + \beta_i(E(R_m) - R_f)$, where $E(R_i)$ is the expected return on the security, $R_f$ is the risk-free rate, $\beta_i$ is the beta of the security, and $E(R_m)$ is the expected return of the market. An increase in the risk-free rate ($R_f$) directly increases the expected return on the security. An increase in the market risk premium ($E(R_m) - R_f$) also increases the expected return, as the security's return is positively related to the market risk premium through its beta.

Question 4

Which one of the following will increase the slope of the security market line? Assume all else constant.
A)increasing the beta of an efficiently-priced portfolio
B)increasing the risk-free rate
C)increasing the market risk premium
D)decreasing the market rate of return
E)replacing a low-beta stock with a high-beta stock within a portfolio

Accepted Answer

Increasing the market risk premium will increase the slope of the security market line, as it represents the additional return expected for taking on more risk.

Question 5

All else held constant, which of the following will increase the expected return on a security based on CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Also assume the beta exceeds 1.0.
I. decrease in the security beta
II. increase in the market risk premium
III. decrease in the risk-free rate
IV. increase in the market rate of return
A)I and III only
B)II and IV only
C)I, II, and IV only
D)II, III, and IV only
E)I, II, III, and IV

Accepted Answer

The answer of All else held constant, which of the...

Question 6

A security has a zero covariance with the market. This means that:
A)the return on the security is always equal to that of the market.
B)the return on the security moves in the same direction as the market return.
C)the security is a risk-free security.
D)there is no identifiable relationship between the return on the security and that of the market.
E)the return on the security must vary more than that of the market.

Accepted Answer

Zero covariance between a security and the market means that there is no identifiable relationship between the return on the security and that of the market. It doesn't mean that the return will always be equal or move in the same direction as the market return, and it doesn't mean that the security is risk-free. It also doesn't necessarily mean that the return on the security will vary more than that of the market.

Question 7

Which of the following will affect the beta value of an individual security?
I. interval of time frequency used for the data sample
II. length of time period used for the data sample
III. particular time period selected for the sampling
IV. choice of index used as the measure of the market
A)I and II only
B)I and III only
C)II and IV only
D)II, III, and IV only
E)I, II, III, and IV

Accepted Answer

All four factors listed (time interval frequency, length of time period, particular time period, and choice of market index) can affect the beta value of an individual security. The beta value measures the sensitivity of the security to changes in the overall market, so changes to any of these factors could impact the correlation between the security and the market. Therefore, all options are correct.

Question 8

Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that:
A)Stock E is preferable to Stock F.
B)Stock D has a higher beta than Stock F.
C)the market risk premium is greater than 6.8 and less than 7.4.
D)Stock F is riskier than Stock D.
E)at least two of the securities are mispriced.

Accepted Answer

The reward-to-risk ratios differ among the stocks, indicating that at least two of them are mispriced relative to each other.

Question 9

Which one of the following has the highest expected risk premium?
A)stock portfolio with a beta of 1.06
B)U.S. Treasury bill
C)individual stock with a beta of 1.46
D)a stock mutual fund with a beta of .89
E)individual stock with a beta of .94

Accepted Answer

The expected risk premium is directly related to the beta of the asset. The higher the beta, the higher the expected risk premium. Therefore, the individual stock with a beta of 1.46 has the highest expected risk premium among the given options.

Question 10

The slope of the security market line is equal to the:
A)market risk premium.
B)risk-free rate of return.
C)market rate of return.
D)market rate of return multiplied by any security's beta, given an inefficient market.
E)market rate of return multiplied by the risk-free rate.

Accepted Answer

The security market line shows the relationship between expected return and beta. The slope of the line represents the market risk premium, which is the additional return investors expect to compensate them for taking on market risk.

Question 11

A portfolio of securities has a beta of 1.14. Given this, you know that:
A)adding another security to the portfolio must lower the portfolio beta.
B)the portfolio has more risk than a risk-free asset but less risk than the market.
C)each of the securities in the portfolio has more risk than an average security.
D)the portfolio has 14% more risk than a risk-free security.
E)the expected return on the portfolio is greater than the expected market return.

Accepted Answer

The answer of A portfolio of securities has a beta...

Question 12

Where will a security plot in relation to the security market line (SML)if it has a beta of 1.1 and is overvalued?
A)to the right of the overall market and above the SML
B)to the right of the overall market and below the SML
C)to the left of the overall market and above the SML
D)to the left of the overall market and below the SML
E)on the SML

Accepted Answer

A security with a beta of 1.1 is more volatile than the overall market, which means it should have a higher expected return to compensate for the additional risk. If it is overvalued, it means that its actual return is higher than its expected return based on its risk level, so it will be plotted to the right of the overall market, but below the SML.

Question 13

The amount of risk premium allocated to Security A is dependent upon which one of the following?
A)unsystematic risk associated only with Security A
B)total risk associated with Security A's classification
C)total surprise associated with Security A
D)the difference between the expected return and the actual return on Security A
E)systematic risk associated with Security A

Accepted Answer

The risk premium is the additional return required by an investor to compensate for the additional risk they are taking on. Systematic risk is the risk that affects the entire market or a particular segment of the market, and cannot be diversified away by adding more securities to a portfolio. Therefore, the risk premium allocated to Security A will be influenced by the systematic risk associated with Security A.

Question 14

What is the beta of an average asset? A)0 B)> 0 but < 1.0 C)< 1.0 D)1.0 E)> 1.0

Accepted Answer

The beta of an average asset is 1.0, indicating that it moves in line with the market.

Question 15

You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security:
A)must have a beta of 1.0.
B)must have a beta of zero.
C)could be a U.S. Treasury bill.
D)could have any beta greater than 1.0.
E)must have a portfolio weight of 50% or more.

Accepted Answer

If the goal is to match the beta of the market, then adding a security with a beta of 1.0 or greater would increase the overall beta of the portfolio. Adding a security with a beta of zero would decrease the overall beta. However, adding a U.S. Treasury bill, which has a beta of zero, would not change the overall beta of the portfolio, so it is the best choice in this scenario.

Question 16

Where will a security plot in relation to the security market line (SML)if it is considered to be a good purchase because it is underpriced?
A)above the SML
B)either on or above the SML
C)on the SML
D)on or below the SML
E)below the SML

Accepted Answer

A security that is underpriced will plot above the SML, indicating that it offers a higher expected return for its level of risk compared to the market's expectation.

Question 17

Which two of the following determine how sensitive a security is relative to movements in the overall market?
I. the standard deviation of the security
II. correlation between the security's return and the market return
III. the volatility of the security relative to the market
IV. the amount of unsystematic risk inherent in the security
A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)III and IV only

Accepted Answer

The two factors that determine how sensitive a security is relative to movements in the overall market are:
II. correlation between the security's return and the market return
III. the volatility of the security relative to the market.

The other factors listed do not specifically relate to sensitivity to market movements.

Question 18

A portfolio beta is computed as which one of the following?
A)weighted average
B)arithmetic average
C)geometric average
D)correlated value
E)covariance value

Accepted Answer

A portfolio beta is computed as a weighted average of the individual asset betas in the portfolio.

Question 19

Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?
A)standard deviation
B)rate of return
C)beta
D)risk premium
E)reward-to-risk ratio

Accepted Answer

The reward-to-risk ratio must be equal for two individual securities if they are correctly priced according to the Capital Asset Pricing Model (CAPM), as it implies that investors are compensated for the risk they take, beyond the risk-free rate, in a way that is proportional to that risk.

Question 20

Which of the following are needed to compute the beta of an individual security?
I. average return on the market for the period
II. standard deviation of the security and the market
III. returns on the security and the market for multiple time periods
IV. correlation of the security to the market
A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)I, II, and III only

Accepted Answer

To compute the beta of an individual security, we need the standard deviation of the security and the market as well as the correlation of the security to the market. Therefore, the correct choices are II and IV only. The average return on the market and returns on the security and the market for multiple time periods are helpful but not necessary for computing the beta.

Quiz 12: Return, Risk, and the Security Market Line

You own a portfolio which is invested equally in two stocks and a risk-free security. Beta is .89 for Stock A and 1.26 for Stock B. Which one of the following will increase the portfolio beta, all else being constant?

Which one of the following is most commonly used as the measure of the overall market rate of return?

Which one of the following will increase the slope of the security market line? Assume all else constant.

A security has a zero covariance with the market. This means that:

Which of the following will affect the beta value of an individual security? I. interval of time frequency used for the data sample II. length of time period used for the data sample III. particular time period selected for the sampling IV. choice of index used as the measure of the market

Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this, you know for certain that:

Which one of the following has the highest expected risk premium?

The slope of the security market line is equal to the:

A portfolio of securities has a beta of 1.14. Given this, you know that:

Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and is overvalued?

The amount of risk premium allocated to Security A is dependent upon which one of the following?

What is the beta of an average asset?

You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourth security such that your portfolio beta will match that of the market. Given this situation, the new security:

Where will a security plot in relation to the security market line (SML) if it is considered to be a good purchase because it is underpriced?

A portfolio beta is computed as which one of the following?

Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?

Which of the following are needed to compute the beta of an individual security? I. average return on the market for the period II. standard deviation of the security and the market III. returns on the security and the market for multiple time periods IV. correlation of the security to the market